Merchandising Operations and the Accounting Cycle - Pearson

LEARNING TIP
The adjusting and closing entries
here are very similar to those
discussed in Chapter 4, pages
172–179. The closing entries also
clear the Cost of Goods Sold
expense account for accumulating
costs in the next period.
242 Part One The Basic Structure of Accounting
• Selling expenses are those expenses related to marketing the company’s products—sales
salaries; sales commissions; advertising; amortization, rent, utilities,
and property taxes on store buildings; amortization on store furniture;
delivery expense; and so on.
• General expenses include office expenses, such as the salaries of the company
president and office employees; amortization, rent, utilities, property taxes
on the home office building; and office supplies.
The Forzani Group Ltd. (Exhibit 5-1) separates store operating (selling) and general
and administrative expenses for reporting on the income statement.
Gross margin minus operating expenses equals income from operations, or
operating income. Many people view operating income as an important indicator
of a business’s performance because it measures the results of the entity’s major
ongoing activities.
The last section of Austin Sound’s income statement is other revenue and expense.
This category reports revenues and expenses that are outside the main operations of
the business. Examples include gains and losses on the sale of capital assets (not
inventory) and gains and losses on lawsuits. Accountants have traditionally viewed
Interest Revenue and Interest Expense as “other” items, because they arise from
loaning money and borrowing money. These are financing activities that are outside
the operating scope of selling merchandise. The Forzani Group Ltd.’s income statement
in Exhibit 5-1 shows interest expense and amortization expense as separate expenses.
The bottom line of the income statement is net income:
Net income = Total revenues and gains – Total expenses and losses
We often hear the term bottom line used to refer to a final result. Bottom line originated
in the position of net income on the income statement.
Statement of Retained Earnings A merchandiser’s statement of retained earnings
looks exactly like that of a service business. In fact, you cannot determine
whether the entity sells merchandise or services from looking at the statement of retained
earnings.
Balance Sheet If the business is a merchandiser, the balance sheet shows inventory
as a major current asset. In contrast, service businesses usually have no inventory
at all or minor amounts of inventory.
Journalizing the Adjusting and Closing Entries for a
Merchandising Business
Exhibit 5-8 presents Austin Sound Centre Inc.’s adjusting entries, which are similar
to those you have seen previously, except for the inventory adjustment [entry (b)].
The closing entries in the exhibit also follow the pattern illustrated in Chapter 4.
The first closing entry debits the revenue accounts for their ending balances. The
offsetting credit of $170,300 transfers their sum to Income Summary. This amount
comes directly from the credit column of the income statement on the work sheet
(Exhibit 5-6).
The second closing entry includes credits to Cost of Goods Sold, to the contra revenue
accounts (Sales Discounts, Sales Returns and Allowances), and to the expense
accounts. The offsetting $116,450 debit to Income Summary represents the amount
of total expenses plus the contra revenue accounts, which come from the debit column
of the income statement on the work sheet.
The last two closing entries close net income from Income Summary and also close
dividends into the Retained Earnings account.
Study Exhibits 5-6, 5-7, and 5-8 carefully because they illustrate the entire
end-of-period process that leads to the financial statements. As you progress
through this book, you may want to refer to these exhibits to refresh your understanding
of the adjusting and closing process for a merchandising business.